By Caroline Valetkevitch

NEW YORK (Reuters) – Investors are anticipating signs that S&P 500 companies’ investment in artificial intelligence is yielding results as the earnings reporting season advances. Despite expected profit growth deceleration, with S&P 500 earnings estimated to have risen 5.3% year-over-year, a decline from the previous quarter's gain of 13.2%, the technology and communication services sectors are projected to exhibit the strongest growth, according to LSEG data as of Friday.

The unofficial start of the earnings period is this week, featuring reports from major financial firms like JPMorgan Chase and Wells Fargo on Friday.

AI-focused companies have significantly influenced earnings since last year, positively affecting market performance. Currently, the S&P 500 is at record highs, up around 21% year-to-date, with tech and communication sectors leading gains since December.

Howard Chan, CEO of Kurv Investment Management in San Francisco, noted, "Many analysts will start looking at how and if a lot of these larger companies can monetize the model that they're training, and we've seen the ones that have been able to do so have been rewarded quite well."

Overall, technology sector earnings are expected to rise by 15.4% from the previous year, while communication services may increase by 12.3%, based on LSEG data.

Shares of Meta Platforms surged on Aug. 1 after posting a positive sales forecast for Q3, indicating that digital ad spending can support its AI investments.

Chan remarked that companies like Microsoft and Google are investing heavily, but the impact on their existing businesses remains unclear.

Investors are hopeful that earnings can validate the higher stock prices, as the S&P 500 trades at 22.3 times forward 12-month earnings estimates, exceeding its long-term average of 15.7, according to LSEG Datastream.

Solita Marcelli, chief investment officer for Americas at UBS Global Wealth Management, mentioned in a note that third-quarter results could catalyze gains as investors concentrate on tech fundamentals and AI. "We continue to favor the semiconductor space and megacaps for AI exposure," she added, expecting tech and AI firms to surpass Q3 expectations and raise their forecasts.

UBS anticipates a substantial revenue increase in the AI semiconductor sector, projecting it to hit $168 billion by year-end.

In general, earnings growth across most S&P 500 sectors is expected to be lower than in the previous quarter.

Concerns about a weakening economy had emerged as the Federal Reserve began a monetary easing cycle, cutting benchmark interest rates by 50 basis points for the first time since 2020 due to signs of trailing labor market. However, these worries abated somewhat following last week's U.S. jobs data, which revealed a notable increase in job gains in September and a drop in the unemployment rate to 4.1%.

Nevertheless, comments regarding consumer health will be closely monitored. Rick Meckler, partner at Cherry Lane Investments, stated, "Lower front-end rates are more helpful to consumers than companies… So the Fed policy is more something that consumer-driven companies could benefit from."

Additionally, many strategists are keen to understand how rising oil prices, amid escalating Middle East tensions, may affect businesses. LSEG data indicates that earnings for the energy sector are expected to decline by 19.7% YoY in Q3.